Current Issues in Financial Reporting - Essay Example

Current Issues in Financial Reporting and Section # of Current Issues in Financial Reporting The International Accounting Standards Board (IASB) has originated the task of set up standards on accounting for financial instruments, including derivatives, as challenging as FASB has. The international regulation on accounting for financial instruments is controlled mainly in two standards: International Accounting Standard (IAS) 32, Financial Instruments: Disclosure and Presentation, and IAS 39, Financial Instruments: Recognition and Measurement (Jones & Elizabeth, 2005). Discussion We have discussed the current issues of financial reporting, which are mostly valued in all companies and noticed what accounting standards tell us about their implementations. The issues are mostly discussed by exposure draft. Exposure Draft The IASB has issued for public comment an exposure draft of proposed amendments to IAS 39, Financial Instruments Recognition and Measurement. The amendments are intended to clarify what can be designated as a hedged item in a hedge accounting relationship. The exposure draft specifies the risks that qualify for designation as hedged risks when an entity hedges its exposure to a financial instrument. In addition, it clarifies when an entity may designate a portion of the cash flows of a financial instrument as a hedged item. Whether a hedge relationship can be designated in this way depends upon whether it is possible to designate as a hedged item a portion of the forecast cash flows that is equivalent to a theoretical sold option embedded in the hedged item. The exposure draft explains how this can be done. In July 2007, the International Financial Reporting Interpretations Committee (IFRIC) issued Interpretation 1 4, IAS 19-The Limit on a Defined Benefit Asset Minimum Funding Requirements and Their Interaction, which addressed defined benefit pension assets and their minimum funding requirements. Exposure Draft has resolved many issues of financial reporting which are discussed below: Fair Value This proposal provides guidance for valuing assets and liabilities that are required to be measured at fair value under other pronouncements. The ultimate goal of the fair-value project is to improve comparability, consistency, and reliability of fair-value measurements by creating a model that can be broadly applied to financial and non-financial assets and liabilities. The framework would also remove policies that disagree with SEC guidelines for investment funds, and clarify the use of fair-value measurements in other authoritative pronouncements. The exposure draft would not replace, but instead would expand upon, current disclosures relating to the use of fair-value measurements for assets and liabilities. Disclosures would include information about fair-value amounts, how they are determined, and the effect of any remeasurement on earnings, including unrealized gains and losses (Aldridge, 1997). Tax uncertainties Once it is determined that a benefit for a tax position may be recognized, the amount must be determined based on the best estimate of the amount that will be sustained. The "best estimate" is defined as the single most likely amount in a range of possible estimated amounts. For example, if a company believes that its position would be sustained on litigation, but typically settles with the taxing jurisdiction to avoid the expense and hazards of litigation, it would record the most likely settlement amount as the benefit. Fundamentally, the proposal entails that a tax position recognized on the tax return be probable of being sustained under audit prior to recognition in the financial statements, and the company must presume that the taxing authorities will review it. In order to derecognize, it must be more likely than not (Glanville, 2004). Business Combination Exposure draft gives some recommendation to avoid any issues, which may arise during business combination, which are: 1. All business combinations within its scope must be accounted for by the purchase method. 2. An acquirer must be identified for every business combination within its scope. 3. The acquirer must recognize all identifiable assets, liabilities, and contingent liabilities of the acquiree at the date of acquisition, regardless of whether the acquiree had previously recognized them. However, the ED specifically prohibits recognition of "acquisition liabilities" not previously recognized on the acquiree's books. 4. The ED prohibits amortization of goodwill, and instead requires that goodwill be tested for impairment. 5. The ED requires disclosure of the effects of business combinations occurring prior to, during, and subsequent to the reporting period. 6. The ED requires disclosures to enable users to evaluate changes in goodwill during the reporting period. Risk and Fraud To provide a richer understanding of the environment in which fraud is likely to occur, the ED expands the description of fraud and its characteristics. It describes three conditions generally present when fraud occurs--incentive/pressure, opportunity and attitude/rationalization. Input from forensic experts, academics and others consistently showed that evaluation of information about fraud was enhanced when auditors considered it in the context of these three conditions. To increase awareness and sensitivity to fraud, and to enhance the fraud-risk-assessment process, the ED requires audit team members to discuss during the planning stage the potential for material misstatements due to fraud. The more experienced team members should share their insights, and all the members should exchange ideas about how and where the entity's financial statements might be susceptible to material misstatements due to fraud (Pacter, 1999). Disclosure To date, professional standards have required different treatments for accounting changes: retrospective application through equity with a restatement of prior period results (hereafter referred to as the restatement method), retrospective application through income with a cumulative adjustment of prior period results reported in current income (hereafter referred to as the cumulative effect method), and prospective application with no adjustment of prior period results (hereafter referred to as the prospective method). In addition, in some circumstances, standards have required disclosure in the footnotes of the pro forma effect of the change on prior periods. The ED requires the restatement method for all changes in accounting principle, both discretionary and mandatory. The ED permits application of the prospective method when it is impracticable to determine the cumulative effect of applying the change to all prior periods. The ED also states that transition guidance will supersede the ED's guidance when explicitly provided in newly issued accounting pronouncements. The ED also mandates specific disclosures in the period of an accounting change. When the change is discretionary, the firm must clearly explain why the newly adopted accounting principle is preferable. In addition, when a change in accounting principle has an effect on the current period or any prior period presented, or may have an effect in subsequent periods, the firm must disclose: (1) the effect of the change on each financial statement line item and any per share amounts affected for the current period and all prior periods presented, where financial statements of subsequent periods need not repeat the disclosures; (2) the amount of any adjustment relating to periods prior to those presented; (3) a statement that comparative information has been restated, or that restatement for a particular prior period has not been made because it is impracticable, together with the reasons for impracticability. The Board notes that this is only the first phase of its project with the FASB to review and harmonize the presentation of financial statements. The second phase, which has already begun, is examining more fundamental questions about the presentation of information in financial statements. While this is a joint project, the IASB expects to issue its own discussion paper on this topic by the end of the first quarter of 2008. 1 would expect the FASB to also issue a discussion paper at about the same time (Yoon, 1998). Hedge Accounting Hedge accounting is dealt with in much more detail in IAS 39 than under UK GAAP. Companies adopting IFRS need to understand the hedge accounting rules and determine the extent, if any, to which they will take advantage of them. It is an area where significant shareholders will need educating about the impact on the company. Take cash flow hedges. These are where a hedging instrument is designed to hedge future cash flow effects of a hedged item. Examples include: * Forward currency contract hedging future foreign sales or purchases (in respect of foreign exchange risk). * Commodity contract hedging highly probable future sales or purchases in respect of commodity price risk. * Variable to fixed interest rate swap hedging interest rate risk on a variable rate debt instrument. In the hedge accounting of cash flow, gains and losses on remeasurement of the hedging instrument to fair value are taken direct to equity - to the extent that the hedge is effective - then subsequently released to the profit and loss (P&L) account to match the related hedged item. Any ineffective element is charged immediately to profit or loss. Hedges of the disclosure to amendments in the fair value of a known asset or liability or an unrecognized firm commitment - or an identified portion of any of these. Examples of where fair value hedge accounting may be used include: * Where an entity has a loan asset at a fixed interest rate, which is carried at amortized cost. It uses an interest rate swap (fixed to variable) to cover the fair value risk. * Where an entity has a commodity asset (e.g. silver) or firm purchase commitment but has a put option to sell. * Where a forward currency contract hedges a firm sales or purchase commitment - though this could alternatively be accounted for as a cash flow hedge (Aldridge, 1997). Amendment to IAS 39 The IASB issued limited amendments to IAS 39, "Financial Instruments: Recognition and Measurement," on the initial recognition of financial assets and financial liabilities. When improving IAS 39, the IASB decided to include guidance on when an entity can recognize gains or losses on initial recognition of financial instruments. Issued in 2003, the revised IAS 39 states that the best evidence of the fair value of a financial instrument at initial recognition is the transaction price, unless the fair value can be evidenced by comparison with other observable current market transactions or is based on a valuation technique whose variables include only data from observable markets. The Standard provides that a "day 1" gain or loss can be recognized only if evidenced this way. The IASB noted that this requirement converged with U.S. GAAP. Conclusion The IASB is now working intensively with all parties to better understand their concerns and find a solution. There are positive signs from recent IASB meetings and the result may be minor amendments to IAS 39, with the aim of removing the necessity for a 'carve-out'. The option to use hedging means similar transactions can be accounted for differently. This makes comparisons between companies difficult on this point. In addition, an individual company may choose to account for similar transactions in different ways. For example, a foreign currency forward contract (hedging instrument) may be used to hedge the foreign exchange effects of future sales or purchases (hedged items). Works cited Aldridge, C. Richard,andJanet L. Colbert.1997."We need better financial reporting."Management Accounting (USA)79.n1:32(5). Glanville, Brian A.,andAlison L. Gerlach.2004."In all fairness."Appraisal Journal72.2:171(4). "Applying IFRS: How hedging can limit the impact of IAS 39."Finance Week(May 4, 2005):19. Jones, Richard CandElizabeth K. Venuti.2005."Accounting and reporting for financial instruments: international developments."The CPA Journal75.2, 30(4). Pacter, P. 1999. International accounting standards: the world's standards by 2002. The CPA Journal, 15-21. Togher, Sean. 2003."IAS 39: making securitization transparent."Risk Management50.8:40(6). Yoon, Y. 1998. Financial reporting in an international environment: a look at regulatory models and the case for a market approach. Multinational Business Review, 6, 29-36. Read More